1. Introduction: Price elasticity of demand is an economic measure that is used to measure the degree of responsiveness of the quantity demanded of a good to change in its price, when all other influences on buyers remain the same.

Elasticity of demand helps the sales manager in fixing the price of his product, deciding the sales, pricing policies and optimal price for their products. The evaluation of this measure is a useful tool for firms in making decisions about pricing and production which will determine the total revenues for the firms.

In our research, we will discuss about price elasticity of demand, we will explain how firms can use the price elasticity of demand for Goods and services to decide on sales, setting pricing policies and determining the optimal price to maximize revenues.

2. Analysis: Before analyzing the effect of price elasticity of demand on change in a firm’s revenue, it is significant to analyze the price elasticity of demand itself.

The price elasticity of demand reflects the relation between price and quantity. An elastic demand means that the quantity demanded is relatively responsive to changes in price i.e. Elasticity > 1. It is calculated as:

Price Elasticity of Demand = % ∆ Quantity demanded % ∆ Price

Sales: After the analysis of price elasticity of demand we can identify the relationship between the prices and firm’s revenue. Given the price elasticity of demand facing the firm in the relevant range of production, how would a change in the price of the good affect a firm's revenues? Remember, if a firm raises prices they reduce sales (for a typical downward sloping demand curve) and the firm increases sales when there is a reduction in prices.

A firm's revenues equals the total sales of a good sold times the price charged:Total Revenue = Price x QuantityTR = P x Q

The effect on total revenue is a factor of the three parts: 1. Change in revenue as a result of change in price on the condition ceteris paribus. 2. Change in revenue as a result of change in volume of sale on the condition ceteris paribus. 3. Change in revenue as a result of both change in volume of sale and change in prices:

The relationship between Price elasticity of demand and total revenue can be also be described as: 1. When the price elasticity of demand for a good is perfectly inelastic (Ed = 0), changes in the price do not affect the quantity demanded for the good; raising prices will cause total revenue to I ncrease. 2. When the price elasticity of demand for a good is relatively inelastic (-1 < Ed < 0), the percentage change in quantity demanded is smaller than that in price. Hence, when the price is raised, the total revenue rises, and vice versa. 3. When the price elasticity of demand for a good is unit (or unitary) elastic (Ed = -1), the percentage change in quantity is equal to that in price, so a change in price will not affect total revenue. 4. When the price elasticity of demand for a good is relatively elastic (-∞ < Ed < -1), the percentage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue falls, and vice...

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PriceElasticity of Demand
Indicates how responsive consumers are to variation in price
When price increases, buy more…but how much more?
Percent change in quantity divided by percent change in price
Similar to miles per hour (100 mi in 2 hours…50 mph)
# is how much more (less) you buy when price falls (rises) $1
NOT slope!
Take absolute value because it is almost always negative
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% ∆ Q = 5%, % ∆ P = 25%....ε = 0.2
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PriceElasticity Of DemandPriceElasticity of Demand is the quantitative measure of consumer behavior whereby there is indication of response of quantity demanded for a product or service to change in price of the good or service ( Mankiw,2007). The PriceElasticity of Demand is calculated using either the point method or the midpoint method.
The Point Method
PriceElasticity of Demand = Percentage change of Quantity Demanded
Percentage change of Price
The Midpoint Method
PriceElasticity of Demand = (Q2 ' Q1) \ [ (Q2 + Q1)/2]
(P2 ' P1) \ [ (P2 + P1)/2]
Were:
Q1= initial Quantity Demanded
Q2 = new Quantity Demanded
P1=Initial Price
P2= new Price
(Source : Mankiw 2007)
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T's Jean Shop sells designer jeans. The latest trend setter has been Capri cuffed blue jeans. The demand for the Capri jeans has been very high with teenagers and young women. The business has increased its supply of Capri jeans due to the high demand. The owner, Terri Johnson, contemplates increasing the price from $9.00 to $10.00. Ms. Johnson needs to know the response of the consumers to the increased price. According to McConnell and Brue (2004), the PriceElasticity of Demand measures the rate of response of quantity demanded due to a price change (p. 1).
Using PriceElasticity of Demand
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percentage change in quantity
demanded of product X
Ed = percentage change in price
of product X
The percentage change in quantity demanded is divided by the percentage change in price.
change in quantity demanded of X
Ed = original quantity demanded of X
change in price of X
original price of X
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Supply, Demand, and PriceElasticity
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Appendix B
PriceElasticity and Supply &amp; Demand
Xeco – 212
02/07/2012
Peter D. Brothers
Fill in the matrix below and describe how changes in price or quantity of the goods and services affect either supply or demand and the equilibrium price. Use the graphs from your book and the Tomlinson video tutorials as a tool to help you answer questions about the changes inprice and quantity
Event | Market affected by event | Shift in supply, demand, or both. Explain your answer. | Change in equilibrium |
Frozen orange crops in California | Orange juice | Supply (left)—Not as many available oranges to offer consumers. | Price will increase and quantity will decrease. |
Hurricanes in the Gulf Coast | Oil | Shift in supply because quantity is limited. Demand will remain the same. | The price of oil will increase because of the decrease in quantity. |
Cost of cotton decreases | Clothing | Increase in both demand and supply due to the decreased price of cotton | Price will decrease when supply increases |
Technology improves efficiency in pasta manufacturing | Grocery stores and restaurants | Increase in supply and demand because manufacturing faster increases supply which decreases price causing an increase in...